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Sustainability in CRE: Part 5 – The Other “Green” Side of Sustainability

In the 5th and final part of our series of posts on sustainability, we focus on the ROI discussion surrounding sustainable and “green” developments and retrofitting projects. We’ll also discuss how “green leasing” may impact those discussions.

Discussions about the sustainable designs and energy-efficiency often focus on the environment, or employee wellness. But as is often the case in commercial real estate, money talks.

A survey of property management professionals from the Institute of Real Estate Management found more than 78% of firms said energy management was either important or very important to their business.

The overwhelming reason – cited by more than 88 percent of respondents, was that it controls expenses. More than 46 percent also cited higher tenant demand and retention as a motivation.

Despite the availability of financial analysis tools focused on sustainability – such as the ENERGY STAR Building Upgrade Value Calculator or NPV and cash flow analyses – the most common financial metrics used to evaluate potential projects are simple payback calculations.

Unsurprisingly, shorter paybacks are generally preferred, with both third-party managers and portfolio ownership professionals saying that acceptable payback time frames are generally between 1 and 4 years.

As the chart also shows, portfolio ownership respondents appear to have greater leeway to pursue 3-4 year projects than third-party firms.

Those time frames may make it more challenging to justify major projects – such as HVAC upgrades – without much greater levels of scrutiny and discussions around financing options.

In many properties, the nature of standard leases is one feature which holds back some ROI discussions, since neither building owners nor tenants are motivated to make wide-reaching changes.

If electricity within a multi-tenant properly is not individually metered, tenants pay the landlord for electrical use based on their pro-rata share of the property. While building ownership may want to reduce energy and water use as a whole, tenants have no financial motivation to follow energy-efficient behaviors within their own space.

When tenants are individually metered or pay their own utility bills, building ownership has no direct benefit in lower costs. Tenants may be motivated by the promise of lowering their bills. However, depending on the term remaining on their lease and whether they anticipating renewing, their window to earn a full payback on their investments is limited.

That divide has led to some parties of incorporating “green lease” provisions into contracts in order to better incentivize efficiency improvements.

These might include sections which allow landlords to pass some of the costs of energy-efficiency capital upgrades on to tenants, or include smaller energy-saving projects as operating expenses charged through common area maintenance charges.

Parties could also agree to confer any tax benefits for upgrades back to the investing party, so that if a tenant upgrades a specific feature which carries a government rebate, the tenant receives the benefit, rather than the property owner.

In the U.S., residential and commercial buildings account for 40 percent of all energy consumption, with office properties remaining a leading user of energy and water. Heating, ventilation, and computing remain the largest energy users.

That high ratio means that each shift in the industry has a tremendous impact.

Recent efforts have already made a significant impact, with the total energy use per SF of commercial properties dropping 12 percent from 2003 to 2012, with the biggest drops seen in lighting and heating.

While of those items is a small step in the larger discussion of reducing energy and water usage, sustainability in commercial real estate is an ongoing discussion which will continue to play a significant role in the market for decades to come.